SHIFT FROM DISABILITY PAY TO PENSIONS FUELS CONCERN
Ensure government pensions and private savings cover the gap, boost investment returns
I n British Columbia, a couple we’ll call David, who is 71, and Celeste, 63, are retired. Celeste, who has a neurological disorder, has been receiving disability payments from her former employer and from the Canada Pension Plan for many years. At 65, she will lose both disability payments and begin receiving retirement benefits from CPP. David recently ended his work as a management consultant. They have one adult child who lives independently. Their problem: will government and work pensions, a suite they rent out in their home and their financial assets support them for the years of their retirement?
“Can we sustain ourselves in retirement?” Celeste asks. “Should we should stay in our present house or must we downsize?”
Family Finance asked financial planner Douglas Nelson, head of Nelson Financial Planning Corp. in Winnipeg, to work with David and Celeste. “Celeste’s job-based disability payments of $36,744 a year will stop at 65,” he says. “Her CPP disability payment, $14,424 a year, will be replaced by $10,200 annual CPP retirement benefits. Some income will begin. Registered retirement income fund benefits for David have to start flowing next year. What we have to do is to balance expected income with spending. It is an essential exercise.”
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BALANCING RETIREMENT BUDGET
There are two stages in the couple’s retirement, Nelson says. Stage one is the present: David’s CPP benefits of $8,016 a year, his Old Age Security of $6,778 a year, Celeste’s two disability payments — which total $51,168 a year — and $12,000 a year in rent from a suite in their home. Those sources of income add up to $77,962 a year. After tax, they have $5,485 a month for expenses and savings.
The second stage will begin in two years when Celeste’s disability payments end. The couple will have annual CPP benefits of $18,216 — $8,016 for David and $10,200 for Celeste; two full OAS benefits, totalling $13,556 a year; Celeste’s work pension of $14,436; $12,000 annual rental income; and David’s annual RRIF distribution of $18,816. It adds up to about $77,024 a year. If eligible pension income is split, then, after tax is reduced by pension income and age credits, they will have $5,775 a month to spend. They may shelter unspent funds in their TFSA if they have room, or make gifts to their grandchild .
If the couple were to sell their $900,000 house and downsize they could liberate perhaps $400,000. That capital could be invested to yield four per cent a year, or $16,000. But they would have to give up $12,000 annual rent from the suite in their home. The difference, $4,000 a year, would be slashed by selling and moving costs. They might downsize further, but their quality of accommodation and perhaps of life would suffer, Nelson says. Moreover, it’s not necessary to cut down their cost of living. In sum, he says, they can keep their B.C. home and a U.S. vacation home too.
MAKING USE OF TAX BREAKS
David and Celeste can increase their discretionary income by applying for the B.C. property tax deferral program. It’s available to residents over 55 at a cost of one per cent annual simple interest. Property taxes deferred must be paid when the property is sold. They would save $4,080 a year, less $41 annual interest.
Money saved could go to fund a Registered Education Savings Plan for a grandchild soon to arrive. If they allocate $2,500 a year from deferred property taxes and receive the $500 annual Canada Education Savings Grant, the $3,000 annual contribution invested to generate three per cent after inflation would grow to $67,250 in 2015 dollars in 17 years and be sufficient for tuition and books at almost any university in B.C. for four years.
DIVERSIFICATION AND REBALANCING
David and Celeste can afford to maintain their present way of life, but their financial assets, which total $654,569, are just a third of their total assets. Apart from two cars worth $18,000, the balance of their assets is in property.
That allocation reflects the soaring price of B.C. real estate. The couple’s present RRSP balances, $451,157, will have to be converted to RRIFs and paid out as annuity income beginning next year for David and in nine years for Celeste. When both are receiving RRIF income they will get about $23,900 a year, depending on growth within the RRIFs. Published RRIF payout schedules as amended by the April 2015 federal budget should expend all capital in each person’s 90s. They would still have two houses and, of course, income from indexed government pensions, Celeste’s small work pension and, perhaps, the rental suite. They can start RRSP distributions soon to average out taxes and park money they do not spend in their TFSAs. It’s their choice.
Historical market studies suggest that the present asset allocation, which has over $50,000 of stock in one large-cap Canadian stock, and $77,000 of cash, should be diversified into broad market funds that emulate the TSX or foreign markets. Foreign market funds can be bought hedged to the Canadian dollar to eliminate the risk and cost of the loonie falling further against the greenback or other currencies, or unhedged if David and Celeste think the loonie will rise. Given that they spend part of the year in the U.S., where they own a condo, they may want to hold a U.S. stock index ETF not hedged to the loonie. The unhedged fraction can be the percentage of time they spend in the U.S. For example, if they are in the U.S. 40 per cent of the year, then 40 per cent of their equity assets could be in a major U.S. stock index fund. The same would apply to their fixed income or bond allocation.
The fixed income component can be investment grade corporate bonds due in five to 10 years, Nelson suggests. Corporate bonds often add a few per cent to the interest government bonds pay. The default rate for investment grade bonds is minuscule and bond index ETFs that hold many hundreds of issues mitigate it.
These balances can be refined in many ways, but the principle of putting money into U.S. assets to cover U.S. costs is reasonable. This plan is just about the easiest way to cover the changing cost of living in the U.S. and, once in place, requires very little tinkering.
A more serious problem is that David and Celeste are disinterested investors. They have sufficient financial assets to hire the services of an independent portfolio manager at an annual fee of one per cent to 1.5 per cent of assets under management. The adviser would no doubt shed expensive mutual funds and produce a tailored portfolio. Their cash hoard needs to be invested to generate more than the one per cent, at best, it now yields.
“The couple can have more financial security and greater ability to pace inflation if they raise their investment returns,” Nelson says. “If they do not want to study financial markets and economics, accounting, and the other skills required for money management, they should consider hiring a manager who has those skills.”